Just Adopted a New 401(k) Plan?  Beware These Common Pitfalls

By June 30, 2022, businesses with 5 or more California employees must either enroll in CalSavers, a state-managed system of Roth IRA accounts, or establish their exemption from CalSavers by adopting 401(k) or other retirement plans of their own.  Other states have implemented or are rolling out similar auto-IRA programs.  Below are some potential pitfalls for new plan adopters that business owners should be aware of, and, where possible, take steps to avoid. 

  1. Immediate top-heavy status.  The “top-heavy” rules compare the combined plan account balances of certain owners and officers, called “key employees,” with the plan account balances of all other plan participants (non-key employees).  If the key employee account balances make up 60% or more of the combined plan account balances of all participants, the plan is top-heavy and the plan sponsor is required to make minimum contributions (generally equal to 3% of compensation) to the accounts of all non-key employees.  A plan can be top-heavy in its first year of operation, although it is more commonly a result of large account balances accumulated over time by long-term key employees, versus smaller accounts held by high-turnover, lower paid employees.   Top-heavy status is particularly likely to arise in a family-owned business, as family members of owners count as key employees, but the problem is not limited to this scenario.  Businesses that anticipate a potential top-heavy problem should consider adopting safe-harbor 401(k) plan designs, as a basic safe-harbor matching or non-elective contribution will satisfy minimum top-heavy contribution requirements.  A SIMPLE-IRA plan is also exempt from top-heavy requirements, provided you have 100 or fewer employees.
  2. ADP/ACP testing failure.     A similar and more common problem, failure of the Actual Deferral Percentage or ADP test, occurs when the average rate of elective deferrals made by Highly Compensated Employees exceeds the average rate of elective deferrals made by non-Highly Compensated Employees by more than a permitted amount.  (A related test, the Actual Contribution Percentage test, applies to matching contributions.)  Highly Compensated Employees (HCEs) are persons who own more than 5% of the company sponsoring the plan at any time during the current or prior year, or who, for the prior year, earned above a set dollar amount.  (For 2022, the amount is $135,000 and applies to 2021 earnings.)  Correcting testing failures will involve refunding amounts to HCEs, or making additional contributions to non-HCEs.  Fortunately there are a number of preventive measures to take, including using a safe harbor contribution formula, using a “top 20%” election to define HCEs, using automatic enrollment at a meaningful percentage of compensation (such as 5% or higher), and robust enrollment meetings and tools to engage employees with savings potentials under the plan. 
  3. Late deposit of elective deferrals.  When you run payroll and pull employee elective deferrals from pay, you have a deadline within which to invest them under your 401(k) plan, which is the point at which they are considered to be “plan assets” under ERISA.  Investment is generally is denoted as a “trade date” by your plan’s recordkeeper, whether Fidelity, Vanguard, or the like.   If you have under 100 participants as of the beginning of your plan year (counting those who are eligible to participate even if they don’t actively do so) you have seven business days to get from pay date, to trade date.  For larger plans, the normal deadline to invest is as soon as elective deferrals can reasonably be segregated from your general assets.  (An outside deadline of 15 business days after the end of the month following the month in which the elective deferrals would have been payable in cash applies in the event of extraordinary circumstances interrupting normal payroll functioning.)  If you fail to meet the seven business-day or “as soon as” deposit deadline, your retention of employee funds constitutes a “prohibited transaction” and an excise tax is payable to the IRS. Additionally, the Department of Labor views it as a fiduciary breach.  It is possible to seek relief from the excise tax and from potential fiduciary liability by participating in the Department of Labor’s Voluntary Fiduciary Compliance Program or VFCP.  Late deposits of employee elective deferrals (and loan repayments) must be disclosed each year on your Form 5500 Return/Report, which in turn could trigger further inquiry, so compliance with your applicable deposit deadline is important.
  4. Plan audit requirementAs we covered in an earlier post, a business sponsoring a brand new 401(k) plan may be required to obtain an audit report on the plan’s operations and finances, prepared by an independent qualified public accountant or IQPA, at an annual expense of $5,000 – $15,000 or more.  These reports generally are required for plans with 100 or more participants as of the first day of the plan year, counting those who are eligible to participate whether or not they actually do so.  Proposed regulations for Form 5500 might change that rule, to count only those with plan account balances, but they have yet to be finalized and put into effect.  Until that time, businesses sponsoring new plans that will cover 100 or more eligible participants need to prepare for the audit process, both in terms of budgeting dollars for the cost, and time to gather responses to the auditor’s questionnaires.  New auditing standards going into effect this year put increased responsibilities on plan sponsors to account for plan operations and documentation.

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2022 Christine P. Roberts, all rights reserved.

Photo credit:  Goh Rhy Yan, Unsplash

How to Prepare Business Owners for the Approaching CalSavers Deadline

CalSavers is a state-run retirement program that applies to employers who do not already sponsor their own retirement plan.  It automatically enrolls eligible employees in a state-managed system of Roth IRA accounts. It has been in place since September 30, 2020 for employers with more than 100 employees and since June 30, 2021 for employers with more than 50 employees.  On June 31, 2022, it goes into effect for employers with 5 or more employees.  Below we cover key aspects of the CalSavers program, focusing on the types of issues that California business owners might bring to their benefits advisor for further clarification. A version of this post was published in the March 2022 issue of Santa Barbara Lawyer magazine.

Q.1:  What is CalSavers?

A.1:  CalSavers is the byproduct of California Senate Bill 1234, which Governor Brown signed into law in 2016. It is codified in Title 21 of the California Government Code and in applicable regulations. It creates a state board tasked with developing a workplace retirement savings program for private for-profit and non-profit employers with at least 5 employees that do not sponsor their own retirement plans (“Eligible Employers”).  Specifically, CalSavers calls for employees aged at least 18, and who receive a Form W-2 from an eligible employer, to be automatically enrolled in the CalSavers program after a 30-day period, during which they may either opt out, or customize their contribution level and investment choices.   The default is an employee contribution of 5% of their wages subject to income tax withholding, automatically increasing each year by 1% to a maximum contribution level of 8%. Employer contributions currently are prohibited, but they may be allowed at a later date.

Q.2:  If a business wants to comply with CalSavers, what does it need to do?

A.2:  The steps are as follows:

  • Prior to their mandatory participation date – which as mentioned is June 30, 2022 for employers with 5 or more employees, Eligible Employers will receive a notice from the CalSavers program containing an access code, and a written notice that may be forwarded to employees. Eligible Employers must log on to the CalSavers site to either register online, or certify their exemption from Calsavers by stating that their business already maintains a retirement plan. The link to do so is here. To do either, the employer will need its federal Employer Identification Number or Tax Identification Number, as well as the access code provided in the CalSavers notice. 
  • Eligible Employers who enroll in CalSavers will provide some basic employee roster information to CalSavers. CalSavers will then contact employees directly to notify them of the program and to instruct them about how to enroll or opt-out online. Those who enroll will have an online account which they can access in order to change their contribution levels or investment selections.
  • Once an Eligible Employer has enrolled in CalSavers, their subsequent obligations are limited to deducting and remitting each enrolled employee’s contributions each pay period, and to adding new eligible employees within 30 days of hire (or of attaining eligibility by turning age 18, if later).
  • Eligible Employers may delegate their third-party payroll provider to fulfill these functions, if the payroll provider agrees and is equipped to do so.  CalSavers provides information on adding payroll representatives once a business registers.

Q.3:  How does a business prove it is exempt from CalSavers?

A.3:  There are several steps:

  • First, it must have a retirement plan in place as of the mandatory participation date.  This may mean a 401(k) plan, a 403(b) plan, a SEP or SIMPLE plan, or a multiple employer (union) plan. 
  • Employers with plans in place must still register with CalSavers to certify their exemption.  The link is at https://employer.calsavers.com (Select “I need to exempt my business” from the pull-down menu.)  They will need their federal Employer Identification Number or Tax Identification Number and an access code that is provided on a notice they should have received from CalSavers.  If they can’t find their notice, they can call (855) 650-6916.  

Q.4:     How does a business count employees, for the 5 or more threshold?

A.4: To count employees for purposes of the 5 or more threshold, a business takes the average number of employees that it reported to the California Environmental Development Department (EDD) for the previous calendar year.  This is done by counting the employees reported to the EDD on Form DE 9C, “Quarterly Contribution Return and Report of Wages (Continuation)” for the quarter ending December 31 and the previous three quarters, counting full- and part-time employees.   So, for example, if a business reported over 5 employees to EDD for the quarter ending December 31, 2021 and the previous three quarters, combined, and it did not maintain a retirement plan, it would need to register with CalSavers by June 30, 2022.  If a business uses staffing agencies or a payroll company, or a professional employer organization, this will impact its employee headcount. The business should seek legal counsel as the applicable regulations are somewhat complex.

Q.5: What are the consequences of noncompliance with CalSavers requirements?

A.5:  There are monetary penalties for noncompliance, imposed on the Eligible Employer by CalSavers working together with the Franchise Tax Board. The penalty is $250 per eligible employee for failure to comply after 90 days of receiving the CalSavers notification, and $500 per eligible employee if noncompliance extends to 180 days or more after the notice.  CalSavers has begun enforcing compliance with the program in early 2022, for employers with more than 100 employees who were required to enroll by the September 30, 2020 deadline.   

Q.6:  Are there any legal challenges to CalSavers?

A.6:  Yes, but the main suit challenging the program has exhausted all appeals, without success. A bit of background information is necessary to understand the legal challenge to CalSavers. The Employee Retirement Income Security Act of 1974 (ERISA) generally preempts state laws relating to benefits, but a Department of Labor “safe harbor” dating back to 1975 excludes from the definition of an ERISA plan certain “completely voluntary” programs with limited employer involvement. 29 C.F.R. § 2510.3-2(d).  The Obama administration finalized regulations in 2016 that would have expressly classified state programs like CalSavers, as exempt from ERISA coverage, and thus permissible for states to impose. However, Congress passed legislation in 2017 that repealed those regulations, such that the 1975 safe harbor remains applicable. Arguing that the autoenrollment feature of CalSavers program makes CalSavers not completely voluntary and thus takes it out of the 1975 regulatory safe harbor, a California taxpayer association argued that ERISA preempts CalSavers.   On March 29, 2019, a federal court judge concluded that ERISA did not prevent operation of the CalSavers program, because the program only applies to employers who do not have retirement plans governed by ERISA.  The Ninth Circuit affirmed.  In late February 2022, the Supreme Court of the United States declined to review the case. Meanwhile, state-operated IRA savings programs are underway in a number of other states, including Oregon, Illinois and New York, and in the formation stages in yet others. 

Q.7:  Does CalSavers apply to out-of-state employers? 

A.7:  It can.  An employer’s eligibility is based on the number of California employees it employs, as reported to EDD. Eligible employees are any individuals who have the status of an employee under California law, who receive wages subject to California taxes, and who are at least 18 years old. If an out-of-state employer has more than 5 employees meeting that description, as measured in the manner described in Q&A 4, then as of June 30, 2022 it would need to either sponsor a retirement plan, or register for CalSavers.

Q.8.  Does CalSavers apply to businesses located in California, with workers who perform services out of state? 

A.8:  Yes, if the employer is not otherwise exempt, and if they have a sufficient number of employees who have the status of an employee under California law, who receive wages subject to California taxes, and who are at least 18 years old.

Q.9: Can an employer be held liable over the costs, or outcome of CalSavers investments?

A.9:  No.  Eligible Employers concerned about lawsuits should be aware that they are shielded from fiduciary liability to employees that might otherwise arise regarding investment performance or other aspects of participation in the CalSavers program.  In that regard, the CalSavers Program Disclosure Booklet, available online, goes into significant detail about the way CalSavers contributions will be invested; notably the cost of these investments (consisting of an underlying fund fee, a state fee, and a program administration fee).

Q.10:  Can an employer share its opinions about CalSavers, to employees?

A.10.  Not really.  Eligible Employers must remain neutral about the CalSavers program and may not encourage employees to participate, or discourage them from doing so. They should refer employees with questions about CalSavers to the CalSavers website or to Client Services at 855-650-6918 or clientservices@calsavers.com.

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2022 Christine P. Roberts, all rights reserved.

When is a 401(k) Not a Retirement Plan?                 

Short answer – a 401(k) plan is not a “retirement plan” for California creditor protection purposes when it was expressly set up to protect IRA rollover assets from creditors. This was the holding in a 2019 California Court of Appeal decision that is still valid law and that is worth revisiting: O’Brien v. AMBS Diagnostics, LLC, 38 Cal. App. 5th 553, 562 (2019), rev. den. 2019 Cal. LEXIS 8003 (October 23, 2019)

Mr. O’Brien got into a legal dispute with his former business partners in AMBS Diagnostics, LLC (AMBS) and lost at trial, resulting in a judgment against him for over $600,000.  AMBS sought to collect on its judgment and filed notices of levy against Mr. O’Brien’s assets, including four IRA accounts then valued at $465,350.  (There was no dispute that the IRA funds had originally been set aside for retirement purposes.)  The court ordered an assessment of what portion of the funds in O’Brien’s IRAs were necessary for his support in retirement and what portion could be used to satisfy the judgment.

This is because, under California Code of Civil Procedure (C.C.P.) § 704.115(a)(3), IRA funds, and funds held in self-employed retirement plans, are exempt from creditors “only to the extent necessary to provide for the support of the judgment debtor,” and their spouse and dependents, upon retirement. This is to be distinguished from protection from bankruptcy creditors, which is governed by federal law (and which exempts up to $1 million, indexed for inflation), and is further to be distinguished from protection of assets held in “[p]rivate retirement plans” that are “established or maintained by private employers or employee organizations, such as unions,” including “closely held corporations.”  Assets held in this fashion are fully protected from creditors under C.C.P. § 704.115(b).  The I.R.S. generally can invade such assets pursuant to a federal tax lien, but that was not at issue in the O’Brien case. 

Mr. O’Brien was aware of the different degree of creditor protection under California law, accorded to IRAs versus employer-sponsored retirement plans.  Accordingly, within 18 days the court order to assess the IRA assets for necessity in retirement, Mr. O’Brien set up a limited liability company and formed a 401(k) plan for the LLC.  He then rolled over his IRA assets to the newly-established 401(k) plan, and then dissolved the LLC.  He also somehow got on the record as admitting that he took these actions to protect his IRA assets from his creditors. AMBS sought to levy funds from the new 401(k) plan but the trial court sided with O’Brien, holding that the funds were fully exempt as held in a “retirement plan” notwithstanding the plan’s recent vintage.

The Court of Appeal reversed on the grounds, in part, that the full exemption available to a retirement plan rests on the assumption that the plan holding the funds was principally or primarily designed and used for retirement purposes, and in light of Mr. O’Brien’s admission the LLC’s plan simply did not meet that standard. “O’Brien freely admitted his subjective intent for creating the 401(k) plan and in transferring the funds . . . ‘[T]he shielding and hiding of assets from creditors is clearly not a “use for retirement purposes.”’”  38 Cal. App. 5th at 562, citing In re Daniel, 771 F.2d 1352, 1358 (9th Cir. 1985), In re Dudley, 249 F.3d 1170, 1177 (9th Cir. 2001), In re Bloom, 839 F.2d 1376, 1378 (9th Cir. 1988).  The court concluded that the 401(k) funds were still subject to the more limited, “as necessary for retirement” protection available to IRA assets and sent the matter back to the trial court for assessment of the funds against that standard, as originally had been intended.  Interestingly, in reaching this conclusion the court favorably cited an earlier decision, McMullen v. Haycock, 147 Cal. App. 4th 753, 755-756 (2007), in which funds in a retirement plan account were held to have kept their higher level of protection against creditors after having been rolled to an IRA.  This “tracing rule” remains citable legal authority in California although it is somewhat at odds with the language of C.C.P. § 704.115(a)(3). 

Would the outcome in the case have been different had O’Brien not been so bold about stating his intentions?  Probably not, though he certainly did not help himself.  The timing of the LLC and plan setup were damning enough in themselves, and it would appear from the opinion that the rollovers were made in violation of the 401(k) plan terms (AMBS alleged that “O’Brien’s purported rollover of funds was invalid because he did not meet the qualifications set forth in the 401(k) plan itself for such a rollover.”)  58 Cal. App. 5th at 558.

Clearly, a poor plan, poorly executed, and an object lesson that creditor protection of retirement plan assets will be based on all the relevant facts and circumstances, not just the name on the account.

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2021 Christine P. Roberts, all rights reserved.

Photo credit: Sasun Bughdaryan, Unsplash

IRS Announces 2022 Retirement Plan Limits

On November 4, 2021, the IRS announced 2022 cost-of-living adjustments for annual contribution and other dollar limits affecting 401(k) and other retirement plans.  The maximum annual limit on salary deferral contributions to 401(k), 403(b), and 457(b) plans increased $1,000 to $20,500, but the catch-up contribution limit for employees aged 50 and older stayed the same at $6,500.  That raises the total deferral limit for a participant aged 50 or older to $27,000.  The Section 415(c) dollar limit for annual additions to a retirement account was increased to $61,000 from $58,000, and the $6,500 catch-up limit increases that to $67,500 for participants aged 50 or older.   In addition, the maximum limit on annual compensation under Section 401(a)(17) increased to $305,000 from $290,000, and the compensation threshold for Highly Compensated Employees increased to $135,000, from $130,000.  Other dollar limits that increased for 2021 are summarized below; citations are to the Internal Revenue Code.  Unchanged were the annual deductible IRA contribution and age 50 catch-up limit ($6,000 and $1,000, respectively), and the age 50 SIMPLE catch-up limit of $3,000.  In a separate announcement, the Social Security Taxable Wage Base for 2022 increased to $147,000 from the prior limit of $142,800 in 2021.

Photo credit: Atturi Jalli, Unsplash.

IRS Prioritizes Guidance on Student Loan Repayment Contributions

On September 9, 2021 the Department of the Treasury issued its 2021-2022 Priority Guidance Plan listing guidance projects that are priorities for the Treasury Department and IRS during the twelve months ending June 30, 2022.  Among the Employee Benefits topics is “[g]uidance on student loan payments and qualified retirement plans and §403(b) plans.” This post reviews the state of the law on student loan repayments through retirement plans and briefly discusses what type of guidance might be forthcoming. 

Current State of the Law

The current state of guidance on using student loan repayments as a base for employer contributions to a qualified retirement plan or 403(b) plan is limited to a private letter ruling issued in 2018 to Abbott Labs.  In addition, proposed measures are contained in various pieces of federal legislation including the Securing a Strong Retirement Act of 2021, commonly referred to as SECURE 2.0.

In the private letter ruling (PLR 201833012), discussed in our earlier post, the employer sought approval of an arrangement under which they made a 5% nonelective contribution on behalf of participants who contributed up to 2% of their compensation towards student loan repayments.  Those participants could still make elective deferral contributions under the plan, but would not receive a matching contribution (also equal to 5% of compensation) for the same pay periods in which they participated in the student loan repayment program.  Both the nonelective and matching contributions were made after the end of the plan year and only on behalf of employees who either were employed on the last day of the plan year or had terminated employment due to death or disability.  The nonelective contributions based on student loan repayments also vested at the same rate as regular matching contributions did.

 The PLR addressed whether the nonelective contribution made on behalf of student loan repayments violated the “contingent benefit rule.”  Under that rule, a 401(k) plan is not qualified if the employer makes any other benefit (with the exception of matching contributions) contingent on whether or not an employee makes elective deferrals.  The IRS concluded that the program did not violate the contingent benefit rule because employees in the program could still make elective deferrals, but simply would not receive the regular employer match on those amounts during pay periods in which they received the nonelective contribution based on student loan repayments.

Only Abbott Labs has reliance on the terms of the PLR, although the PLR may indicate the approach the IRS will take in any new guidance regarding student loan repayments as a basis for retirement plan contributions.  

Proposed Legislation

Congress has noticed the impact that student loan repayment obligations has had on employees’ ability to save for retirement.  As mentioned, the most significant bill that would address this issue is the Securing a Strong Retirement Act of 2021, commonly known as SECURE 2.0.  Specifically, Section 109 of the Bill would treat “qualified student loan payments” equal to elective deferral contributions, for purposes of employer matching contributions under a 401(k) plan, a 403(b) plan, a governmental 457(b) plan, or a SIMPLE IRA plan, and would permit separate nondiscrimination testing of employees who receive the matching contribution based on student loan repayments.  “Qualified student loan payments” would be defined to include any indebtedness incurred by the employee in order to pay their own higher education expenses.   Under SECURE 2.0, total student loan repayments that are matched, plus conventional elective deferrals, would be capped at the dollar limit under Internal Revenue Code (“Code”) Section 402(g) ($19,500 in 2021).   

What Future IRS Guidance Might Hold

Based on the Abbott Labs PLR and SECURE 2.0, we might hope or anticipate that any future IRS guidance on programs that condition employer retirement plan contributions on participant student loan repayments would include the following:

  • Guidance on how such programs may comply with the contingent benefit rule, including whether it will suffice simply that program participants may continue making elective salary deferrals (while likely foregoing regular matching contributions while student loan repayments are being matched).
  • Guidance on whether such a program, by nature limited to employees with student loans, is a “benefit, right or feature” that must be made available on a nondiscriminatory manner under Code Section 401(a)(4), and if so how it might satisfy applicable requirements.
  • Guidance on whether, and how, employers can confirm that loan repayments are being made, including whether (as SECURE 2.0 would permit), employers may rely on an employee’s certification of repayment status.
  • Guidance on nondiscrimination testing of contributions under a student loan repayment program, including provision for separate testing, as SECURE 2.0 would permit.

Additionally, plan sponsors would no doubt appreciate guidance on use of outside vendors for student loan repayment programs and how they might interact with conventional retirement plan record keepers and third party administrators.

Photo credit:  Mohammad Shahhosseini, Unsplash

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2021 Christine P. Roberts, all rights reserved.

The Song Remains the Same: Few 2021 COLA Adjustments for Retirement Plans

On October 26, 2020, the IRS announced 2021 cost-of-living adjustments for annual contribution and other dollar limits affecting 401(k) and other retirement plans.  The maximum annual limit on salary deferral contributions to 401(k), 403(b), and 457 plans remained the same for 2021 as it was in 2020, at $19,500, and the catch-up contribution limit for employees age 50 and older also stayed the same at $6,500.  The SIMPLE employee contribution limit of $13,500 was also unchanged, as were the annual deductible IRA contribution and age 50 catch-up limits ($6,000 and $1,000, respectively).  The Section 415(c) dollar limit for annual additions to a retirement account was increased to $58,000 from $57,000 and the maximum limit on annual compensation under Section 401(a)(17) increased from $285,000 to $290,000.  Below we list the changed and unchanged dollar limits for 2021. Citations below are to the Internal Revenue Code. (Click on the chart for a larger image.)

In a separate announcement, the Social Security Taxable Wage Base for 2021 increased to $142,800 from the prior limit of 137,700 in 2020.

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. (c) 2020 Christine P. Roberts, all rights reserved.

Photo Credit: Jude Beck, Unsplash

California Employers: Get Ready for the CalSavers Program

Beginning on July 1, 2019, California private employers with 5 or more employees, who do not already sponsor a retirement plan, may enroll in the CalSavers Retirement Savings Program (CalSavers).   Mandated employers must enroll in CalSavers according to the following schedule:

  • Over 100 employees – June 30, 2020
  • 50-99 employees – June 30, 2021
  • 5-49 more employees – June 30, 2022

Below, we describe the key features of the CalSavers program.

  • CalSavers is the byproduct of California Senate Bill 1234, which Governor Brown signed into law in 2016. It is codified in Title 21 of the Government Code and in applicable regulations. It creates a state board tasked with developing a workplace retirement savings program for employers with at least 5 employees that do not sponsor their own retirement plans (“Eligible Employers”). This may mean a 401(k) plan, a 403(b) plan, a SEP or SIMPLE plan, or a multiple employer (union) plan.
  • CalSavers applies to private for-profit and non-profit employers, but not to federal or state governmental entities.
  • CalSavers calls for employees aged at least 18, and receiving a Form W-2 from an eligible employer, to be automatically enrolled in the CalSavers program after a 30 day period, during which they may either opt out, or customize their contribution level and investment choices.
  • The default is an employee contribution of 5% of their wages subject to income tax withholding, automatically increasing each year by 1% to a maximum contribution level of 8%. Employer contributions currently are prohibited, but may be allowed at a later date.
  • Prior to their mandatory participation date, Eligible Employers will receive a notice from the CalSavers program containing an access code, and a written notice that may be forwarded to employees. Eligible Employers must log on to the CalSavers site to either register online, or certify their exemption from Calsavers by stating that their business already maintains a retirement plan. The link to do so is here. To do either, you will need your federal tax ID number and your California payroll tax number, as well as the access code provided in the CalSavers Notice.
  • Eligible Employers who enroll in CalSavers will provide some basic employee roster information to CalSavers. CalSavers will then contact employees directly to notify them of the program and to instruct them about how to enroll or opt-out online. Those who enroll will have an online account which they can access in order to change their contribution levels or investment selections.
  • Once an Eligible Employer has enrolled in CalSavers, their subsequent obligations are limited to deducting and remitting each enrolled employee’s contributions each pay period, and to adding new eligible employees within 30 days of hire (or of attaining eligibility by turning age 18, if later).
  • Eligible employers may delegate their third party payroll provider to fulfill these functions, if the payroll provider agrees and is equipped to do so.
  • Eligible Employers are shielded from fiduciary liability to employees that might otherwise arise regarding investment performance or other aspects of participation in the CalSavers program.
  • There are employer penalties for noncompliance. The penalty is $250 per eligible employee for failure to comply after 90 days of receiving the CalSavers notification, and $500 per eligible employee if noncompliance extends to 180 days or more after the notice.
  • Eligible Employers must remain neutral about the CalSavers program and may not encourage employees to participate, or discourage them from doing so. They should refer employees with questions about CalSavers to the CalSavers website or to Client Services at 855-650-6918 or clientservices@calsavers.com.

The CalSavers program was challenged in court by a California taxpayer association, on the grounds that it was preempted by ERISA as a consequence of the automatic enrollment feature.[1] On March 29, 2019, a federal court judge concluded that ERISA did not prevent operation of the CalSavers program, because the program only applies to employers who do not have retirement plans governed by ERISA.  The taxpayer association is deciding whether to amend their complaint by May 25, 2019, or appeal the decision to the Ninth Circuit.  Therefore, further litigation may ensue, but after this important early victory the timely rollout of CalSavers seems likely, and employers should act accordingly.  (Programs similar to CalSavers are up and running in Oregon and Illinois, and have been proposed in a handful of other states.)

Employers reviewing this information should pause to re-examine their earlier decisions against maintaining a retirement plan for employees. The benefit of sponsoring your own plan is that it will bear the “brand” of your business and will serve to attract and retain quality employees.  Further, the administrative functions you must fulfill in order to participate in CalSavers are comparable to those required by a SEP or SIMPLE plan, both of which offer larger contribution limits and an employer deduction to boot.  If mandatory participation in CalSavers is bearing down on your business, now is a good time to talk to a retirement plan consultant, or your CPA or attorney, to determine whether you can leverage the time investment CalSavers will require, into a retirement arrangement that offers considerably more to your business and your employees.

In the meantime, here are some online resources for Eligible Employers:

  • Employer checklist – a punchlist to help you prepare for enrollment.
  • CalSavers Program Disclosure Booklet – this goes into significant detail about the way CalSavers contributions will be invested; notably the cost of these investments (consisting of an underlying fund fee, a state fee, and a program administration fee), will range at launch between $0.83 to $0.95 for every $100 invested, which is approximately twice the cost load for typical 401(k) investments.  It is expected that the fees will drop as the assets in the program grow, according to a breakpoint schedule approved by the CalSavers board and program administrator.
  • Online FAQ

[1] A Department of Labor “safe harbor” dating back to 1975 excludes “completely voluntary” programs with limited employer involvement from the definition of an ERISA plan.  29 C.F.R. § 2510.3-2(d).  The Obama administration finalized regulations in 2016 that would have expressly permitted state programs like CalSavers as exempt from ERISA coverage. However, Congress passed legislation in 2017 that repealed those regulations.

The above information is provided for general informational purposes only and does not create an attorney-client relationship between the author and the reader.  Readers should not apply the information to any specific factual situation other than on the advice of an attorney engaged specifically for that or a related purpose.  © 2019 Christine P. Roberts, all rights reserved.

Bankruptcy Case Highlights Importance of Promptly Transferring Retirement Assets in Divorce

When a couple divorce, it is not uncommon for one partner to have accumulated significantly larger retirement accounts (e.g., in 401(k) plans or IRAs) than the other.  In such cases the parties generally divide IRA accounts pursuant to Internal Revenue Code 408(d)(6) and/or enter into a qualified domestic relations order (QDRO) to divide a 401(k) or other qualified retirement plan.

The importance of moving promptly to divide and transfer title to retirement accounts in divorce was highlighted in a Bankruptcy Court case from 2018, In re Lerbakken, 590 B.R. 895 (8th Cir. 2018).  In the case, the husband’s failure to take formal legal custody of half of his ex-wife’s 401(k) account (through obtaining a QDRO), and the entirety of one of her IRAs, resulted in those amounts becoming available to creditors in the husband’s bankruptcy case.

In Lerbakken, the court’s dissolution order/property settlement directed Lerbakken’s attorney to submit a QDRO with respect to the 401(k) account, and presumably contained language relevant to transferring title to the IRA, for which a QDRO is not necessary.  However no steps towards obtaining a QDRO or transferring title of the IRA were taken.  When Lerbakken filed a voluntary Chapter 7 bankruptcy petition, he claimed his share of the 401(k) account, and the IRA, as exempt retirement accounts.  The bankruptcy court disallowed the exemption on the basis of the Supreme Court’s opinion in Clark v. Rameker, 134 S.Ct. 2242 (2014), which held that a non-spousal inherited IRA (in that case, from a mother to a daughter) was not entitled to the same protection from bankruptcy creditors as are retirement funds that are individually set aside by the person claiming bankruptcy protection; e.g. inherited accounts are more in the nature of a financial windfall than an intended source of retirement living expenses.

On appeal, the Bankruptcy panel of the 8th Circuit court agreed, noting that Clark v. Rameker limits the bankruptcy exemption to “individuals who create and contribute funds into the retirement account,” and disregarding Lerbakken’s claim that he would use the funds for retirement income.  The court’s final summing up suggests that a different result would have obtained,  had Lerbakken obtained a QDRO and moved the IRA funds into his own name, rather than simply having relied on the wording of the property settlement:

            “We recognize that Lerbakken’s interest in the 401(k) and IRA did not arise in the identical manner as the IRA account addressed in Clark.  This distinction is not material to our de novo review.  Any interest he holds in the Accounts resulted from nothing more than a property settlement.  Applying the reasoning of Clark the 401(k) and IRA accounts are not retirement funds which qualify as exempt under federal law.”  (Emphasis added.)

In essence, the result is that without having taken actual ownership to the retirement funds, Lerbakken could not “borrow” the exemption status for the 401(k) and IRA that his wife would have been able to claim, had she been the bankruptcy debtor.  The fact that Lerbakken himself may have been saving money during the marriage to allow for his ex-wife’s 401(k) and IRA contributions simply does not come into play.   The Lerbakken opinion did not address the question of how one of Lerbakken’s creditors (who included his family law counsel) would actually obtain the assets still held in the ex wife’s 401(k) account and IRA, but presumably they would intervene in any attempt to later transfer these amounts over to Lerbakken or to accounts established on his behalf.

As legal precedent, the Lerbakken ruling is limited to states in the 8th Circuit, namely Arkansas, Iowa, Minnesota, Missouri, Nebraska, and North and South Dakota, but it’s invocation of the Supreme Court’s Clark v. Rameker decision could be invoked in other districts.  It is also possible that this concept could influence state courts deciding the rights of non-bankruptcy creditors.  It therefore provides a timely reminder of the importance of moving promptly to obtain a QDRO and to move IRA assets pursuant to Internal Revenue Code 408(d)(6) pursuant to divorce.  Sitting on your rights in such instances could result in loss of the protected status of retirement savings in a bankruptcy or possibly other creditor situation.

The above information is provided for general informational purposes only and does not create an attorney-client relationship between the author and the reader.  Readers should not apply the information to any specific factual situation other than on the advice of an attorney engaged specifically for that or a related purpose.  © 2019 Christine P. Roberts, all rights reserved.

Beyond the 403(b) Plan: Top 5 Things to Know About Deferred Compensation for Non-Profit Executives

Tax-exempt employers may offer deferred compensation plans to their select executives to allow for retirement savings over and above the dollar limits applicable under a Section 403(b) plan. However the rules governing these arrangements, which fall under Section 457 of the Internal Revenue Code (Code), are complex and often misunderstood.  Below are five things top things to keep in mind in this area, to get the most that the law offers without unpleasant tax surprises along the way.

1.  It’s complicated……

First, there are two types of 457 plans: 457(b) plans and 457(f) plans.  A tax-exempt employer can use both for the same executives but careful planning is advised.  The (b) plans allow set-aside (in the form of employee deferrals or employer contributions) of only $18,000 (in 2017) per year, with no age 50+ catch-up allowance.  Amounts set aside under a (b) plan are not taxed until they are distributed to the executive, an event which must be delayed until termination of employment/retirement, or on the occurrence of unforeseeable circumstances (narrowly defined).  Taxation is delayed until distribution even though the amounts are generally “vested” (no longer subject to forfeiture) when they are contributed.  By contrast there is no dollar limit on the amount that may be set aside under a 457(f) plan (subject to item no. 4, below), but the amounts are taxable upon completion of a vesting schedule (e.g., from 3 to 10 years).  Therefore distribution in full almost always happens upon completion of vesting.  Put most simply, (b) plans are a good way to double an executive’s 403(b) deferral budget, and (f) plans are a good way to help an executive catch up on retirement savings when a retirement or other departure date is within a 3 to 10 year time horizon. Further, in order for an exemption from ERISA to apply, participation in these plans must be limited to a “select group of management or highly compensated employees,” comprising no more than 5% – 10% of the total workforce, referred to as the “top-hat” group.  In a small tax-exempt employer with 10 or 20 employees this may mean only 1 or 2 executives may participate.

2.  You (usually) can’t roll to an IRA.

Generally when an executive is ready to take distribution of benefits from a 457(b) or (f) plan a taxable cash distribution is required, and rollover to an IRA is not an option. (One exception is when the executive moves to a new employer that maintains a 457(b) plan that accepts rollover contributions).  Under a (b) plan, which may allow installment distributions over a period of years, the lack of an IRA rollover option is not so severe, but in a 457(f) plan setting, which generally calls for lump-sum distributions, the tax impact can be severe and the executives should be advised to do advance tax planning with their own CPAs or other tax advisors, well ahead of their planned retirement date or other vesting trigger.  In my experience, lack of the IRA rollover option often comes as an unwelcome surprise to the covered executives.

3.  The assets belong to the organization.

Section 457 plans are non-qualified meaning in relevant part that they assets the plans hold belong to the tax-exempt organization that sponsors the plan until the date(s) they are paid out to the participants. The assets must be held in an account in the name of the organization “FBO” the 457 plan account for the name of the executive.  There is no form of creditor protection but it is possible to put in place a “rabbi trust,” so called because the trust format was first approved by the IRS on behalf of a synagogue for its spiritual leader.  The rabbi trust will not protect the 457 assets from the organization’s creditors, but it will prevent the organization from reneging on the deferred compensation promise to an executive.  This is particularly helpful for an organization that anticipates changes in its board structure after approval of a 457 arrangement.

4.  The normal “reasonable compensation” rules still apply.

Tax-exempt organizations must pay only reasonable compensation, in light of the services provided, to employees and other individuals who comprise “disqualified persons,” a category that includes executive directors and other “C-suite” members. Under the “intermediate sanction” regime the IRS imposes excise taxes on individuals who benefit under, and organization managers (e.g., board members) who approve, compensation arrangements that fail the reasonableness standard.  Deferred compensation arrangements must be reasonable in light of all other compensation and benefits provided to the executives in question and in most cases this will require a third-party compensation consultant’s evaluation and review.  This is a vitally important and often-overlooked piece of deferred compensation compliance in the tax-exempt arena.

5.  DOL notification is required.

As part of the ERISA exemption for top-hat deferred compensation plans, a tax-exempt organization must provide a “top-hat notification letter” to the Department of Labor within 120 days of implementing such a plan. Top-hat letters must be filed electronically.  Failure to timely file a top-hat letter could mean that your deferred compensation plan is liable for ERISA penalties for failure to file annual information returns (Form 5500), to hold plan assets in trust, to make certain disclosures to participants, and on a host of other compliance points.  The Department of Labor permits late filing of top-hat notification letters for payment of a modest fee.  If your organization has a deferred compensation plan in place you should have ready access to a copy of the top-hat notification letter (or confirmation of its online filing) and should consider the DOL correction program if you cannot do so.

Having practiced law in Santa Barbara, California, a haven for charitable organizations, for over 20 years I have had the privilege of working with these special deferred compensation plan rules in many different factual settings and would be happy to help your organization navigate them in order to best retain and reward your valued executives.

The Emerging Benefit Trend of Student Loan Assistance

Employers are by now familiar with the scary statistics on mounting student loan indebtedness, including that approximately 71% of 2015 college seniors graduated with a student loan, and almost 80% of millennials believe that student loan debt will make it harder for them to meet their financial goals.  Per Mark Kantrowitz of Cappex.com, the average student loan balance increased by almost 50% between 2005 and 2015, and now hovers around $35,000 per graduate.

Large student loan debt impacts current employees and prospective new hires in many ways: it may cause rejection of a desired position or promotion due to income needs, it may postpone retirement plan participation due to cash flow needs, and it may delay or even rule out home ownership or starting families, leading to a less stable and community-involved workforce.

Employers want to be able to help mitigate some of the downside of high student loan debt among their employees, but their efforts are hindered by the fact that employer loan payments on behalf of an employee are currently taxable to the employee.

Several pieces of new legislation proposed for the 2017-2018 Congressional term encourage or facilitate employer assistance with student loan repayments through tax incentives. A survey of some of these measures follows:

The Higher Education Loan Payments (HELP) for Students and Parents Act (H.R. 1656)

  • This measure would permit employers to make up to $5,250 per year in tax-free student loan repayments on behalf of employees, and provide an employer tax credit based on 50% of contributions made within that dollar limit.
  • It would also permit employers to make up to $5,250 per year in the form of “qualified dependent 529 contributions” direct to employees’ tax-exempt tuition savings accounts set up on behalf of their children (up to age 19; students up to age 24), and would provide a corresponding 50% employer tax credit.
  • If passed it would thereby double the current $5,250 limit on employer education assistance under Internal Revenue Code (“Code) § 127.
  • Significant for smaller employers, the HELP for Students and Parents Act would treat sole proprietors and partners as employees for purposes of the excludible contributions.

The Student Loan Repayment Act (H.R. 615)

  • This bill would offer employers a 3-year business tax credit equal to 50% of startup costs for a student loan program (up to $500 per participating employee) under which the employer matches employees’ student loan repayments, up to $2,000 per year.
  • The startup costs are program creation costs, not amounts used for employer matching contributions.
  • The bill would also allow employers who hire “qualified student loan repayers” to claim the Work Opportunity Tax Credit, which encourages hiring of select populations such as veterans and recipients of certain types of public assistance. A “qualified student loan repayer” must have at least an associate’s degree, and outstanding education loans of at least $10,000.

The Student Loan Repayment Assistance Act (H.R. 108)

  • This bill would amend the Code to allow businesses a tax credit for employer-paid student loan repayments made direct to the lender, equal to 10% of the amounts that the employer pays on behalf of any employee, not to exceed $500 per employee per month.
  • The credit would be refundable for small businesses and non-profits who cannot use the credit against taxes.
  • The bill would require a written plan document, notice to employees, annual reporting to IRS and must be made “widely available” to employees (not discriminate in favor of “highly compensated employees”).

The Retirement Improvement and Savings Enhancement (RISE) Act of 2016

  • This measure took the form of a discussion draft in the 2014-2016 Congress but likely will be re-introduced in the current 115th Congress.
  • It would permit employers to make matching contributions to an employee’s 401(k) or SIMPLE IRA account based on his or her student loan repayments, essentially treating employee student loan repayment as equivalent of a 401(k) salary deferral.
  • Its retirement provisions would also curtail currently permissible IRA strategies including “mega Roth IRAs” and stretch IRAs, and would permit IRA contributions after reaching age 70 1/2.

As legislative efforts progress, vendors are already stepping in to the breach. Tuition.io provides a software interface that permits employer money to go direct to repay student loans, without going through employee pay.  The average employer contribution per paycheck is $50 – $200.   Other vendors include Student Loan Genius, PeopleJoy, Peanut Butter, and Gradifi.

One compliance question that these programs raise is whether student loan repayment programs would comprise ERISA plans, subject to trust and reporting requirements, or simply be viewed as “payroll practices” exempt from Title I of ERISA.  They do not provide retirement income or defer compensation to retirement age, thus would not likely be an ERISA pension plan, and do not provide benefits within the definition of ERISA “health and welfare” plans, so probably would not fall within ERISA’s scope.  This should help encourage formation of these programs by employers, as ERISA compliance burdens can be complicated and costly. Employers may still need to meet certain requirements in order to ensure tax-qualified status, however, as in the case of the Student Loan Repayment Assistance Act, which imposes documentation, notice and reporting duties.

Employers that want to address their employees’ student loan debt through workplace financial assistance can take the following steps to help select the program or policy that best suits their needs:

  • Talk to your recruiters and use other methods to estimate the student loan burden faced by your staff and new hire candidates.
  • Carefully evaluate various student loan aid vendors and identify those with the best fit for your organization.
  • Invest time in plan design and scheduling a roll out.
  • Remember that communication and ease of use are both key success factors.
  • Continue to monitor legislation for new assistance options.